Friday, December 23, 2011

Let's Play Analogies With John Cochrane

Why do Republicans have such a hard time understanding basic economics? Because all they care about is making rich people richer. Here's Yglesias setting another idiot Rethug straight on the basics.--SS

Defenders think that devaluing would fool workers into a bout of “competitiveness,” as if people wouldn’t realize they were being paid in Monopoly money. If devaluing the currency made countries competitive, Zimbabwe be the richest country on Earth.

Try this mode of argument on for size. If water made agriculture possible, then the Pacific Ocean would be the breadbasket of the earth. Or: If flooding is a problem, then the Sahara Desert would be the best place to live. Right?

So let's talk about Spain. For a while, a lot of capital was flowing into Spain from abroad. A very large share of that capital went to finance house-building rather than productivity-enhancing factories or infrastructure. But it employed a lot of people in the construction sector and related fields, which pushed tax and spending levels up and also led to rising wages. Then the housing boom ends, the capital flows end, and suddenly Spain has to adjust to a new equilibrium in which most people are a bit poorer than they were before. The most natural way to do this would be through a bit of currency depreciation. Everyone's nominal wages and pension payouts and local debts to one another are reduced. It's a bummer. But everyone goes on doing the best they can to make a living, and people who are underpaid in the new equilibrium set about to bargain for raises. Depreciation makes vacations in Spain cheap, it makes Spanish exports cheap, and it makes it attractive for rich foreigners to actually go buy up excess Spanish housing stock to use as vacation homes and such. Everyone's taken a hit, but they're back on the path to growth.

The other alternative -- the road we're actually traveling down -- is one in which all of these adjustments need to happen piecemeal. To make the same adjustment happen, every single contract in the country needs to be piecemeal renegotiated. That's every town budget, every cell phone plan, every commercial lease, every salary, etc. It's not "impossible" but it's a logistical and political nightmare. And it takes time. During that time instead of everyone working harder because they're poorer and more indebted than they realized and need to raise their incomes what happens is that 10-20 percent of the population does nothing because they can't find jobs. It's a nightmare and no economy is flexible enough to make it work. You wouldn't just need to repeal the basics of human psychology, you'd need to live in a world where there are no transaction costs and no fixed contracts. Imagine if your boss cut your salary 3 percent and then you set about to try to negotiate a 3 percent discount from your landlord, the electric company, your car insurance, your cable provider, your cell phone carrier, your health insurance plan, and everyone else you owe money to. By contrast, if the trade-weighted value of the dollar were to fall three percent then you have a nice, simple, logistically feasible adjustment that improves the cost structure of U.S.-based exporters and export-competing firms.

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